Rail Renaissance: Returns, Capital & Capacity AB HATCH 155 W68th St Suite 1117 NYC REF11/La Quinta! March 2011

 Economic malaise  Rising capital requirements  Regulation  Maritime trade flows Rail Assessment OpportunitiesThreats Strengths  Pricing  Volume Growth  Service levels / productivity  Modal shift  Consolidation?  Strong secular growth  Favorable market structure  Supply constraints  Solid barriers to entry  Limited alternatives Challenges  Capital intensity  Capacity bottlenecks  Port congestion  Reliability vs. trucks

2010 – Recovery is not just an Eminem song Rails (all modes) surprised by the volume strength 2010 & Q4 results exceed street expectations 2011 – guidance increased and confidence raised Capex numbers way up – so are overall free cash flows

Future Growth Potential Oil, Carbon, Infrastructure & Efficiency Intermodal – International and Domestic Grain – the world’s breadbasket Coal? Exports The Manifest/Carload “Problem” MSW (garbage), perishables, others Point-to-point vs. Hub & Spoke (or Southwest vs. United)

Intermodal Growth Drivers Domestic and International Globalization Trade Railroad Cost Advantages Share Recovery From Highway Truckload Issues

U.S. Railroad Intermodal Traffic (millions) Source: Association of American Railroads’ Weekly Railroad Traffic 2010 through 36 weeks = %

Domestic Intermodal The real growth opportunity is the age-old goal of taking trucks off of the highway Driving down the LOH (requires very tight service standards) Corridor development (see NS’ “Crescent”); truck partnerships (see JBHunt) Fuel price, carbon footprint, infrastructre shortages and congestion, driver shortages (CSA 2010) Trailer (TOFC/”Piggyback”) the gateway drug” for containerization Opportunities in unitized carload as well

2007 CS: Future Corridor Volumes Compared to Current Corridor Capacity (Cambridge/AAR) without improvements Below capacity Near capacity At capacity Above capacity

Carbon Footprint– from cocktail chatter to decision point 2003 – 221/F500 report on carbon; 409/F500 in ’09 Green supply chains enforcement by Wal-Mart (from $2B transport spend to $4B+ by ’11); GE, P&G, etc…. Anticipating future EPA regs and emissions law

S0 -What is the growth rate? Great studies done – in 2007 Is there a “Great Re-set”? (paper, autos, retail, coal) Or do we look past 2035 and simply add a few “lost” years? (the emerging consensus save for the coal question) AAR new assumptions suggest coal is flat from DOT projections while the rest reaches 2025 targets despite Great Recession impact (ie; future intermodal/carload growth is higher than recent studies…) Will the government policy help to increase modal share by 10%?

UNCERTAIN  Domestic Coal Rail Intermediate term volume prospects ABOVE GDP BELOW GDP  Paper  Auto Parts (?) ABOVE GDP  Intermodal – Domestic (++)  Intermodal - International  Agricultural products  Export Coal  Ethanol GDP-GROWTH  Autos  Lumber  Chemicals (+?)  Aggregates  Metals

Growth is Expensive Huge Capex - $40B in the last 5 years in the US – through the Great Recession! % (wide range) – recovery, tax rules AND: Comeback of the share repo/DPS? EPS beat the Street consistently, yet: Uneven returns in the Modern Age Recent improving trend line Threats to ROIC threaten capacity

Rail Rates Began to Rise *Revenue per ton-mile Source: AAR % Change in Avg. Inflation-Adjusted Rail Rates* First meaningful increases since 1980, with much of it tied to higher fuel costs

Railroad Rates- the old story Class I Railroads, Revenue Per Ton-Mile – another (related) New Paradigm Cents Source: Railroad Facts, AAR Current $: Up 5% since 1981 Constant $: Down 54% since 1981

Finally, Railroads Making Decent Money... Net Income Source: AAR

RR CoC vs. ROIC – RR Stocks have done well but… they still trade at a discount to all stocks Source: Surface Transportation Board 2009p Cost of Capital is AAR filing, not decided by STB Note: Cost of equity estimation method changed by Board effective 2006 and 2008.

 Just ONE example of a “future consideration”  25% tax credit (for rails or shippers) for projects that expand rail capacity  Expense other infrastructure capital expenditures  Leverage private investment Tax Incentives to Leverage Capacity Expansion

Rail Capacity and Capex Rail Capacity is extremely fungible Heavier/faster track, double track., sidings; Larger cars (avg size: ’80 79tons; ‘ ’ ) Unitization, shuttle trains Denser systems ( mm RTMs/mi; ’ ) IT – planning, signaling, communications (PTC?) Unitization Equipment in storage (down to the dregs) T&E employees System Velocity

Net Income RRs Still Making Record Re-Investments RR Spending Per Mile Source: AAR

Source: Association of American Railroads Net Income Capital Spending Class I Railroad Capital Spending vs. Net Income (Current Dollars)

Railroad Capital Expenditures Class I Railroads Billions Source: Railroad Facts & Analysis of Class I Railroads, AAR

Positive Train Control (PTC) “Unfunded Mandate” – part of 2008 safety bill Overseer is FRA – who puts cost/benefit ratio at 22:1 Rails have put cost of installation and maintenance at $10B – and rising Possible benefits in capacity, velocity, fuel consumption as well as safety; many of those captured by other technological advances Covers all rail interaction with passengers and TIH as of 2008; short lines exempted Technology proven only in limited scope (BN/Wabtec: ”ETMS”) Initiated after Chatsworth accident – obvious public benefits – some political support brewing?

Railroad Capital Spending ($ billions, constant 2009 dollars) Data are for Class I railroads. Source: AAR

Source: AAR Revenue Volume Productivity Price Staggers Act Passed Oct The Staggers Act: An American Success Story (Index 1981 = 100) Productivity decline due mainly to fuel price volatility.

Railroad Employee Productivity Class I Railroads, Ton-Miles Per Freight Service Employee Source: Railroad Facts, AAR Millions

Rail Service Cycles Is the recent improvement in the metrics sustainable? Systemic? Is it a product of huge capex injection and IT? Or, is it merely a product of lower volumes/less stress on the network…

Capacity Constraints ROIC and ReReg The revival of passenger railroading (the vast majority of which is on freight network) HSR (and HrSR) TIH/NIH issues TSA and secuirity NIMBY – see the CN and its tortured purchase of the EJ&E; efforts on MSW

Current Issues Rails in the Recovery (and beyond) What’s true? RR traffic or business headlines? After the Rereg Fight what? STB? TSW? HSR? Govt role –partner? Or preoccupied &broke? The Green mantle – two-edged sword…. PE &Infrastructure funds – back for good? Panama Canal? New “Golden Age”? Service

Service will be the Key to the Next Cycle Service at all time highs $40B spend in last 5 years (service ought to be better!) Putting increased traffic back on at current velocity means: Higher asset utilization, more market share gains, greater operating leverage (perfect circle affects all stakeholders) Implications for equipment fleets

Street influence on RRs – and Why that affects ALL stakeholders Battle for cash Management’s reactions to pressures Investors, competitors, regulators, politicians, labor – oh, yes, and customers Rare Industry: Short term decisions (current economic outlook)/long term consequences (40+ year life of a locomotive) Remember 2004! (?) – rails unprepared for volume; embargoes Which “bucket” (Capex, share repo, DPS) will they place their chips?

Simple Math Rates Returns Capital Expenditures Capacity Service ARE ALL CONNECTED! Virtuous Circle (’03-07) or Disinvestment?

RR/Investor Issues Summary- 3Rs3Cs Recovery? The Re-Set Re-Regulation Capital Needs Capital Cooperation Cash Flow

Developing website TopShipper Survey RailTrends 2011 November 1-2

Warren’s $44B “all-in” bet Advantages of going private? (capex cycle) Influence in DC “Robber Baron” vs. “Sage” Bets not (just) on economy – rereg, coal, western intermodal Bought on the cheap! “How do you like me now????”